1. Lesson 10: Legacy Costs Justin Marlowe
PBAF 522 – Public Financial Management and Budgeting
Autumn 2015

2. Key Takeaways
Many state and local governments face significant long-term financial challenges related to entitlements, infrastructure funding, pensions, OPEB, debt affordability, and other issues
Medicare and Medicaid (especially for the states) will consume an ever-larger share of the federal and state budgets, respectively; that growth is almost entirely a function of demographics and health care cost inflation
Absent major changes in the structure of these programs, they will continue to grow and put pressure on government and non-profit budgets everywhere
Liabilities for pensions and OPEB are based on estimates, and those estimates are sensitive to assumptions about discount rates, financial market conditions, inflation, etc.

3. The federal government is expected to run massive budget deficits for the next 30 years
Federal government revenues and spending, actual and projected; source: Congressional Budget Office

4. What’s driving most of this? Demographic Change

5. Another Big Problem: Pensions and OPEB
State and local governments collect and invest money to pay future pension and other post-employment benefits (OPEB; mainly health care)
The ratio of those investment assets to expected long-term pension/OPEB spending is known as the funding ratio
Estimated total unfunded state and local government pension liability is $1-2 trillion; unfunded OPEB liabilities are around $2 trillion
State and local governments can affect their funding ratios by changing how they invest their pension assets, changing their discount rate on investments and liabilities, or changing the structure of pension/OPEB benefits

6. State and local government unfunded pension liabilities compound the problem
Unfunded state and local pension liabilities as a share of national GDP; source: Pew Research Centers

7. Pension Funding Ratios vary a lot across states
Pension Funded Ratios by state, as of FY 2012; source: Standard & Poors

8. Most states have done little to fund their OPEB liabilities
OPEB Funded Ratios by state as of FY 2014; source: S&P

9. Don’t forget about the others
Unfunded Infrastructure Maintenance
According to the US Society of Civil Engineers, it would cost around $2 trillion to upgrade our “critically deficient” roads, bridges, and other infrastructure and…
It would cost around $5 trillion to upgrade all our “moderate to critically deficient” infrastructure; that’s about the total amount of the entire municipal bond market
No obvious alternative funding source in sight
Growth in state Medicaid spending mirrors growth in Medicare; demographic change and health care cost inflation